You may have heard of Bitcoin and Ethereum. You’ve also probably heard that people are making thousands, if not millions, of dollars by “investing” in cryptocurrencies. But what is it? Or, better yet, what is the point of cryptocurrencies?
The main purpose of cryptocurrencies is to solve the problems of traditional currencies by putting power and responsibility in the hands of the holders of the currency. All cryptocurrencies adhere to the 5 properties and 3 functions of money.
They also attempt to solve one or more real-world problems. Let’s see how cryptocurrencies work and why more and more people are starting to appreciate this new evolution of money.
1. Cryptocurrencies belong to everyone
Cryptocurrencies work similar to any traditional national currency, with a few differences. There “Fiat money” current is created and regulated by a government agency, which represented from now on a debt. Anyone who owns a country’s currency holds an IOU issued by that country. The cryptocurrency does not represent a debt.
It strictly represents itself, and its value is determined by what someone is willing to trade for it. The fact that cryptocurrency is decentralized plays a vital role in how its value is determined. Nobody owns or regulates a cryptocurrency. Its value is not subject to the political whims of a country or the monetary policy of a central bank.
Remark: some may consider the lack of centralization of cryptocurrencies as a method of avoiding taxes. However, like stocks and bonds, cryptocurrencies are considered an asset. In the United States, they are subject to capital gains tax on sale or exchange.
Currencies operating from a centralized ledger (i.e. a single entity maintaining transaction records, such as a national central bank) are exposed to human manipulation and corruption. By being decentralized, cryptocurrency operates on a “distributed ledger” or shared list of transactions. This type of ledger is the heart of cryptocurrency and brings us to the next reason why cryptocurrency matters.
2. Cryptocurrencies are virtually impossible to fake
Cryptocurrencies run on a blockchain, which is the distributed ledger we talked about above. Understanding blockchain technology will not only help you understand what cryptocurrency is and why it is digital currency power key. The “block” is composed of chunks of encrypted data.
The “chain” is the public database in which blocks are stored and linked to each other sequentially. Each block of the blockchain has a specific code that distinguishes it from all other existing blocks.
This unique code is called a hash. Blocks of information added to a blockchain are added chronologically. A new block is added directly after the last created block, which also has its own unique hash. The blockchain ledger or block database is distributed simultaneously worldwidedistributed among thousands, or in the case of Ethereum and Bitcoin, millions of computers.
There you have it, a simple explanation of cryptocurrency. Now suppose someone wants to tamper with a single block of data on the chain. In this case, he must manipulate all blocks from a given point in history AND update all computers holding copies of the blockchain’s ledger. It’s theoretically possible, but the amount of power and money needed to do it successfully makes the attempt practically impossible.
3. Cryptocurrency transactions are (largely) confidential
With traditional currencies issued by governments, you can make a private transaction or pay for something in person using physical species. Paper, metal, cloth and plastic currencies represent only a tiny fraction of the total amount of most fiat currencies in circulation. Large withdrawals of physical cash are promptly reported and reviewed by a central authority such as governments and financial system regulators.
Remark: monitoring large cash transactions is a good thing. It preserves the legitimacy of the currency and deters criminal enterprises such as money laundering.
Cryptocurrencies are different. They depend on well-designed mathematics to track the exchange between two people or companies. This exchange mostly done anonymously.
While the ledger or list of transactions is publicly available worldwide, parties that trade cryptocurrencies are more private. By definition, cryptocurrencies are held electronically in digital wallets. The owner is the private key holder of the wallet.
The currency is exchanged digitally from mostly anonymous user-owned wallets.
Other remark: Although cryptocurrencies are supposed to be anonymous, advanced forensic analysis can uncover the identity of wallet holders. Some cryptocurrency projects, like Monero, are designed to resist identity discovery.
A few companies like Titan Bitcoin offer premium physical coins, minted with cryptocurrency addresses and verifiable values stored on the blockchain.
It’s an exciting concept for enthusiasts, collectors, and even gifts. He brings a little digital cryptocurrency in the real world. Disclosure: This is not a paid sponsorship. The author, Data Overhaulers, nor its parent company hold bitcoin currency at the time of publication.
4. Security of cryptocurrencies increases over time and in value
Earlier we explained that a hacking or manipulation required an enormous amount of power and money, to the point of becoming a worthless effort. To go further, a hacker would need to control more than 50% of the computers that make up the “consensus” network.
The consensus network is simply the collection of computers that receive copies of the blockchain or distributed ledger. For more established cryptocurrencies like Bitcoin or Ethereum, cryptocurrency networks are so large thathacking is virtually impossible.
In the early days of cryptocurrencies, it was easier to gain the majority of control because the cryptocurrency network itself was much smaller. This is an important fact to remember for investors or users of newer cryptocurrencies whose networks have not reached a relatively large size.
The smaller the network, the more vulnerable it is to hacking. An example of this almost happened to early Bitcoin: a group known as BitFury pooled large numbers of computers for “mining”
What is Cryptocurrency Mining?
Mining is the process by which cryptocurrency transactions are verified, and blocks are assigned their hashes. It requires a lot of computing power. Users who lend their computers to the network of cryptocurrency validators receive rewards (through transaction fees) paid in the cryptocurrency they support. BitFury created a mining pool or verification network, which became very profitable as the value of bitcoin increased.
However, in 2014 they were close to reaching fifty percent of the network’s overall strength. Although hacking and manipulating the blockchain is not their goal, they have decided to limit the size of their influence on the Bitcoin network.
The owners of the pool have promised never to exceed forty percent of the overall strength of the network. They did this to protect bitcoin’s value, as holders of the currency might fear a 51% attack from a single trader. If the value of bitcoin crashed, BitFury’s profits would have been affected, if not completely wiped out.
L’balance necessary between potential profit and network power is another form of blockchain security. Too much network power will lead to loss of profit and currency stability.
— Trading du Coin (@TradingduCoin) May 23, 2022
So what is the point of Crypto?
Imagine a situation where you want to send money to an online friend to their account. There are many ways this transaction could go wrong. Particularly :
- The bank or financial institution may experience a technical error, such as machines not working well or systems failing
- Your account can be hacked; for example, there may be identity theft or denial of service
- Your friend’s account or your account may have exceeded the limit.
All of these scenarios are possible because there is a central point of failure: The financial institution. And that is why cryptocurrencies were created as the future of money! Now imagine the same scenario between two people using a bitcoin app or another cryptocurrency. An alert appears asking if you are sure you want to send bitcoins. If you accept, the transaction is processed immediately. The system authenticates the user’s identity and checks if you have the required balance to process the transaction. Then the payment is transferred to your friend’s wallet.
The transaction is much smoother as it is straight forward without any technical issues or procedural steps associated with banks. The goal of cryptocurrencies is to remove all the problems associated with traditional banking.
There are no limits to the money you can transfer using bitcoin, accounts are almost impossible to hack because you don’t use a financial institution, and there is no central point of failure. Also, international cryptocurrency transactions are faster than traditional wire transfers, which have been around since 1872, or any other transfer method.
Unlike wire transfers that take hours or even days, cryptocurrency transfers only take minutes or even seconds.
Cryptocurrency is a way for us to make transfers electronic peer-to-peer without the risk that a single entity gets too much power over the monetary system. The merits of crypto-currencies are still in their beginnings.
The followers and enthusiasts will continue to sing the praises of cryptocurrencies.
The experts will continue to measure this new financial tool against established currencies and real money. the average consumer has to decide which is a good time to test the place of cryptocurrencies in your life.
As blockchain technology continues to mature and useful blockchains surface in the mainstream, the necessity of cryptocurrency and its place in your financial toolbox will inevitably become obvious.